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International Picture, December 18, 2006

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December 18, 2006

U.S. current account deficit exceeded $900 billion for the first time in the third quarter

by Robert E. Scott

The Bureau of Economic Analysis announced today that the current account deficit reached an all-time high annual rate of $902 billion in the third quarter, an increase of $34 billion over the previous quarter.1  The deficit increased to 6.8% of gross domestic product, an increase of 0.2 percentage points.  The deficit was also the second the highest ever, as a share of GDP. The growth of the current account deficit was caused by rapid growth of imports from China and in crude oil and petroleum products. These imports were also responsible for 61.6% of the total current account deficit in the third quarter.  Although declining oil prices may reduce the deficit in the fourth quarter, the rapid growth in Chinese imports and in interest payments to foreign holders of government debt will continue to put upward pressure on the current account deficit in the future.

The U.S. deficit on goods and services trade increased $7.2 billion (3.9% at a quarterly rate2) in the third quarter alone.  Imports increased $17.3 billion (3.2%) to $566 billion, the highest rate since the fourth quarter of 2005. Oil imports increased $4.9 billion (6.2%) to $84 billion.3  Imports from China increased $10.3 billion (15.1%, not seasonally adjusted) to $78 billion.  U.S. exports rose $10 billion (2.8%) to $366 billion in the third quarter, the slowest rate of growth in the past year. 

Imports were 38.7% larger than exports in the third quarter.  Exports would have had to increase 38.7% faster than imports (or 4.0%) just to keep the trade deficit from growing.  In the absence of a dramatic and sustained slowdown in U.S. growth, exports can grow more than 40% faster than imports only with a substantial reduction in the value of the U.S. dollar. When the dollar rises in value, U.S. exports become more expensive and import prices fall.  Between 1995 and 2002, the dollar gained about 30% in value, as shown in the chart below.  As a result, the U.S. trade deficit has grown from about 1.5% of GDP to 6.8%, which experts believe to be far above a sustainable level.  In order to reduce the deficit back to a sustainable level of less than 3% of GDP, the dollar must fall by at least 30% to 40% to reduce export prices and achieve the needed increase in export growth, relative to imports.  A falling dollar will also raise import prices, slowing import growth and increasing demand for goods produced in the United States.

U.S. current account deficit and the dollar, 1973-2006

East Asian governments’ practice of propping up the value of the dollar to promote their export-led growth is the largest barrier to needed dollar adjustments.   Although the U.S. dollar has fallen 12.3% in value since 2002:II, this decline has not been sufficient to slow the growth of the trade deficit.  Although the real value of the dollar has fallen 23.0% against a basket of major currencies in this period, it has fallen only 2.6% against a group of other important currencies, particularly the Chinese yuan.  Much more depreciation will be needed to substantially reduce or eliminate the deficit.  Foreign central banks, which purchase treasury bills and other government securities to suppress their currencies, financed 35.8% of the U.S. current account deficit in the third quarter. Asian governments were responsible for all of these dollar purchases.

Net income on foreign investments, including interest payments on the rapidly growing stock of foreign debt, increased $1.7 billion in the third quarter and was responsible for nearly 20% of the increase in the current account deficit.  Rapidly growing interest payments to foreign holders of U.S. securities are responsible for this entire income deficit, and those payments will grow rapidly in the future for two reasons.  First, foreign holdings of U.S. treasury securities are expected to grow rapidly to finance growing current account deficits. Second, rising interest rates could cause payments on existing debt to increase sharply in the future even if the deficit is reduced. 

As long as the United States maintains sizeable current account deficits, net borrowing and payments to foreign investors will continue to grow.   The standard of living of future generations will be depressed by the need to pay for today’s heavy borrowing from abroad.

For more information about the current account deficit and the costs of foreign borrowing, see the December 2004 Issue Brief, Debt and the Dollar, by EPI economist L. Josh Bivens.

Notes
1. The current account is the broadest measure of the U.S. balance of trade in goods, services, and payments to the rest of the world.

2. Trade data presented at quarterly rates for comparison purposes.

3. U.S. Census Bureau, FT900: U.S. International Trade in Goods and Services, October 2006.  Petroleum imports are seasonally adjusted.  Imports from China are not available on a seasonally adjusted basis and tend to surge in the third quarter in anticipation of holiday sales.

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